Innovation, Information Assymetry, and GMO Lemons

Proposition 37, the Mandatory Labeling of Genetically Engineered Food Initiative, is on the November ballot here in California and the outcome will shape the path of innovation in food and agriculture for decades to come.

If approved, Prop 37 will require labeling on raw or processed
food offered for sale to consumers if the food is made from plants
or animals with genetic material changed in specified ways, and it
will prohibit labeling or advertising such food as "natural."1

While this is about letting people know what they're eating,
there's also a larger issue lurking in the background. If
Proposition 37 passes, it opens the door to a range of innovations
in the quality of food available. If it fails, innovation will
continue its trajectory of industrial science in support of
industrial food.

There is a simple reason at work here that lies at the
foundation of modern economic theory. It explains how Prop 37
provides the very information on which innovations in food quality
depend and why large corporations want to keep it private.2

In 1970, economist George Ackerlof published an article in the
Quarterly Journal of Economics entitled "The Market for Lemons."3 It
would become one of the most influential papers in modern economic
theory and, for it, he would win the Nobel Prize in 2001 (with
Michael Spence and Joseph Stiglitz).

Professor Ackerlof's article described how "information
asymmetry" shaped the quality of goods in markets.
Professor Ackerlof showed that, when sellers had more knowledge of
their offerings than buyers, bad quality products or services would
eventually drive out the good.

His famous example is the used-car market, where buyers can't
distinguish between bad (lemons) and good (cherries) cars until
it's too late. As a result, to offset the probability of driving
off with a lemon, they reduce the amount they're willing to pay for
a car. Since this reduced price is less than what good cars are
worth (but perfectly acceptable for those selling lemons), people
stop selling good cars and the market fills with lemons.

As Ackerlof explained:

"There may be potential buyers of good quality products and
there may be potential sellers of such products in the appropriate
price range; however, the presence of people who wish to pawn bad
wares as good wares tends to drive out the legitimate business. The
cost of dishonesty, therefore, lies not only in the amount by which
the purchaser is cheated; the cost also must include the loss
incurred from driving legitimate business out of existence."
(Ackerlof, p 495)

The nature of innovation turns on these information asymmetries
in the market. When buyers can't distinguish between good and bad
cars, between genetically modified organism (GMO) and non-GMO food,
or between any other means by which consumers might value goods,
innovations that increase those qualities of
products go unrewarded while investments
thatreduce those qualities in pursuit of price or
profitability get rewarded. Even when there are customers
in the market who want those qualities and are willing to pay more
for them.

Corporations have good reason to fear the loss of their
information asymmetries.

The recent publicity of pink slime, the meat additive, led to an
80% loss of its business within three months; leaked videos of
animal cruelty forced rapid disavowals by Target, McDonalds,
In-n-Out and others; the exploitive working conditions of contract
factories blemished Apple's brand (and Nike's before them); and the
sugary drink bans in schools and in New York city are spreading
across the country.

There is much to modern industrial agriculture and the foods it
produces that consumers may not want to support. The GMO seeds and
their accompanying pesticides are certainly one element, but also
the cruelty inherent in factory-raised animals, the technologies
and chemicals associated with industrial food processing, and the
ubiquitous use of pharmaceuticals and growth hormones in the meat
and dairy industry.

"I received a panicky phone call from someone in the food
industry, a buyer for one of the big food-service companies. After
venting about the 'irrationality' of the American consumer, he then
demanded to know: 'who's going to be hit next? It could be anyone
of us.'"

Behind this fear, Pollan explains, is that "a label on
genetically modified food is so terrifying: we (the consumers)
might react "irrationally" and decline to buy it."

The organic label has created its own set of information
assymetries.
Corporate influence in organics, has dramatically increased the
number of nonorganic materials approved for organic foods.
Initially made up of 77 things that, like baking soda, were
nonorganic but essential to making organic bread has grown to more
than 250 nonorganic substances.

Whether you're buying used cars, organic bread, or GMO-based
breakfast cereal, if you don't know what you're buying, you'll soon
be buying lemons. Only when we can distinguish between the good and
the bad - on our terms - will we open the way for sustaining
innovations in agriculture, food, and nutrition.

Footnotes:

1
In addition, there is an exemption from this requirement for foods
that are "certified organic; unintentionally produced with
genetically engineered material; made from animals fed or injected
with genetically engineered material but not genetically engineered
themselves; processed with or containing only small amounts of
genetically engineered ingredients; administered for treatment of
medical conditions; sold for immediate consumption such as in a
restaurant; or alcoholic beverages."

2
[The list of donors](http://bit.ly/SdGgCS) to the No on
37 campaign is an inventory of the global corporations that produce
GMO seeds and accompanying pesticides and the food and soft-drink
companies that rely on the low-cost corn (and high-fructose corn
syrup) that GMO-based agriculture provides them. To date, these
companies have spent roughly $44 million for television
advertising. Monsanto alone has invested more in defeating this
proposition that the $7 million raised by the its supporters.

3
Akerlof, George A. (1970). "The Market for 'Lemons': Quality
Uncertainty and the Market Mechanism". Quarterly Journal of
Economics (The MIT Press) 84 (3): 488-500. Interestingly, the paper
was rejected from both the American Economic Review and the Review
of Economic Studies as too trivial, then a third, the Journal of
Political Economy, rejected it because it had to be wrong.

Part of Series

Andrew Hargadon is the Charles J. Soderquist Chair in Entrepreneurship and Professor of Technology Management at the Graduate School of Management at University of California, Davis. Hargadon's research focuses on the effective management of innovation, particularly sustainable innovation, and he is author of numerous articles, essays, and the book How Breakthroughs Happen: The Surprising Truth About How Companies Innovate (Harvard Business School Press).